Purposeful Capitalism describes an evolution of capitalism wherein the investment industry becomes more professional, ethical, and client-centric.
The scenario detailed in the Future State of the Investment Profession study examines ways in which organisations may evolve with greater focus placed on transforming culture; the integration of environmental, social, and governance (ESG) factors; and their relationship to investment and organisational risk management.
To gain a better understanding of the Purposeful Capitalism scenario, how it might influence risk management, and the evaluation of organisational culture and values, we discussed these topics with Lutfey Siddiqi, CFA.
As an advisory board member at the London School of Economics (LSE) Systemic Risk Centre and a founding faculty member of the Risk Management Institute at the National University of Singapore, Siddiqi is in a unique position to provide insight into the future of risk management and its role within the investment management industry.
He is a member of the Future of Finance Content Council, where he helps the initiative create and disseminate content, and a former board member of CFA Society Singapore. Siddiqi is a visiting professor-in-practice at LSE as well as a member of the World Economic Forum Council on Long-Term Investing and Infrastructure, the Bretton Woods Committee, and an advisory board of the Official Monetary and Financial Institutions Forum (OMFIF).
CFA Institute: Can you explain why risk management is not about tools and metrics but about people, conduct, processes, and culture?
Lutfey Siddiqi, CFA: This was best summarized by the chief risk officer of a major bank in the aftermath of the financial crisis: “We were on the beach, analysing grains of sand with powerful microscopes, totally missing the tsunami that was coming towards us.” Tools, models, and metrics can help us frame risk. What they don’t do is make decisions for us. Risk management is about assessing trade-offs and making judgment calls. How we are empowered as employees, how we collaborate with or challenge each other as colleagues, and how much ownership we feel for firm-wide results have a bearing on the risk-preparedness of our organisation. Malcolm Gladwell points out, in his book Outliers, how plane crashes could be averted by changing the culture in the cockpit — the ease with which a subordinate is allowed to challenge the decisions of the captain. Diversity is a tool of risk management. It is true not only for portfolio diversification but also in diversifying the range of perspectives that people bring to the table. Risk committees (as with governance boards in general) and committee proceedings should be deliberately designed to bring out blind spots. They should be periodically reviewed for how decisions are made.
In the “Purposeful Capitalism” scenario, investment organisations differentiate themselves with reference to values and culture. How do you see this being done and integrated into business models alongside profit motivations?
The first step towards building trust in the profession is to affirm the purpose of the profession. Every organisation will have to become increasingly explicit about its purpose; its organisational culture will follow from that. Starting with conduct is the wrong way ‘round. What do you talk about in employee appraisal sessions or in your town halls? Is it a narrow set of immediate P&L targets or is it a wider set of outcomes for the full set of stakeholders? How do you explain or justify “difficult decisions”? Purpose can provide organisational framework and strategic direction at a time of industry-wide structural change. Purpose can provide an avenue of employee motivation, engagement, and retention. Purpose — when clearly articulated and followed through with action — can also build goodwill. However, enlightened self-interest may not be sufficient to create a bandwagon effect. Movements such as CFA societies can help convene industry leaders to overcome coordination failure.
How does this relate to organisational risk management and what is referred to as risk resilience?
Risk resilience is about the capacity of an organisation to bounce back from an unanticipated risk event. How do you respond when a risk event occurs? Do you have a set of basic principles or some cultural touchstones to fall back on? If your focus is client-first, you are probably asking, “How can I make this right for my client?” If your focus is immediate return on equity first, you might be asking, “How can I hide this until next year?” Organisations that put up posters of generic values but offer no guidance on the ranking among those values fail to be resilient when a situation presents itself.
Take another example: Do you have such a dominant culture of secrecy (and a low level of trust among colleagues) such that lessons learned in one part of the organisation are not shared with other parts?
The scenario also contemplates ESG and stewardship becoming completely mainstream as a component of investment risk management. Considering the acceptance of ESG today, is this likely? What needs to happen for this to be a reality?
There is no doubt that our socio-political environment, powered by social media, will require ever-higher levels of transparency and real-time accountability from large organisations. While the current level of assets under management in designated ESG funds remains limited, mainstream investment firms are already devoting disproportionate resources toward governance and stewardship across all their funds. Take the July 2017 ESG report from Standard Life Investments as an example. More recently, BlackRock made steep fee cuts to their socially-responsible ETFs, “purposefully leveraging the benefits of their global scale.” As some of the largest players in the industry demonstrate leadership of this kind, more and more institutions will be incentivised to parade their ESG credentials. All of it will be helped by the Sustainable Development Goals (SDG) and the bandwagon effect that they have created. While we need to remain cautious against ‘impact washing’ and tokenism, the fact that board governance is also becoming more active and professional will help ensure that fund management will become more responsible. We are nearing a tipping point beyond which absence of ESG sensitivity will prove costly for any firm.
The scenario asks the question “Are portfolios’ exposures to externalities just about financial risk because any pro-social issues lie with governments?” Can financial institutions be involved in pro-social issues or will the reputational risks be too high?
This remains an open question and one that generates considerable debate. Are we veering too far from our core business or indeed from our fiduciary responsibility by taking positions on social issues that are not yet settled? I understand the point about reputation risk and the risk of becoming politically entangled. However, it is important to acknowledge that in certain situations, inaction can pose reputation risk as well. It loops back to purpose, values, and the culture and communication around them. The clearer the organisational purpose, the clearer the conduct.
You can read more insights and research by visiting the Future State of the Investment Professional report by CFA Institute.